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Does this Venture Capitalist (VC) really want to invest in my firm?

Dave, I received the following message. Should I bother following up with this firm?

I was referred to your site by my colleague who expressed great interest in YourSiteName. We are a $2 billion venture capital firm specializing in software technology and have recently invested significant amounts of capital into the internet business...

Dave's Answer:

It's definitely nice and flattering that you're on the radar screen of a large investor, but I surmise that they're not going to be worth you devoting any of your time in responding, even if you are looking for VC money.

Here's why: venture capital firms have a simple formula that defines their smallest possible investment that goes roughly like this:

    minimum individual investment = total investment pool /
      (# partners * # companies each can comfortably manage)

Let's assume that they really do have a $2bil fund. Let's further assume that they're a typical VC firm with a dozen partners and another dozen support staff. Let's further assume that they're smart enough to position themselves as conservative investors (yeah, an oxymoron, but bear with me) and have pledged that they'd only invest $1bil of this latest fund with the second bil held for follow-on investments. A typical partner can handle about a dozen companies, and an associate about 8-10, max, but let's just assume 12 companies per person too.

Now we have some numbers:

      MII = $1 bil / (24 * 12) = $1 bil / 288 = 3.47 million

Now, since anyone who wants to retain control over their destiny is unlikely to sell more than 49% of their company to an investor (and 25-33% is more likely, even with an anti-dilution clause), that means that your company would need to be able to justify a base valuation of 2x, if not 3x, that MII, or $7 million.

Is your business worth $7 million to an investor?

Maybe, but that would make you what VCs call a "medium early stage" business, which means you already have a revenue stream and have already established your corporate management and culture (e.g., you aren't an entrepreneur with a really rockin' AdSense stream :-)

Don't forget that just about all venture capitalists are totally risk averse at the end of the day too. That's the secret of VC that we entrepreneurs aren't supposed to know, but that's why it's almost impossible to get any money from a legit VC unless you have a known management team and/or track record yourself and/or are a leader in a "hot" segment.

Also, don't forget that investors as a whole are just as interested in your exit strategy as your business: without an exit strategy there's no real way on the horizon for them to realize any gain in their investment, and precious few investors want to own a piece of your business forever. What's a typical exit strategy? An M&A (merger and acquisition, it's jargon that refers to when another company buys your little firm) or an IPO (initial public offering, it's when private stock can be sold on the open market because the company becomes publicly traded).

Perhaps not the answer you were seeking, but that's my advice regarding this letter you've received from an ostensible investor. Good luck to you!


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Categorized: Business and Management   (Article 4030, Written by )
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Reader Comments To Date: 1

James said, on June 10, 2005 10:41 AM:

Your hint towards the 49% in the VC market is slightly inaccurate. VCs will never take a majority ownership in a company as they understand the importance of the original folk having more skin in the game.

The other thought is I covered the relationship between VCs and Enterprise Architecture which provides additional clues for funding...

http://blogs.ittoolbox.com/eai/leadership

Starbucks coffee cup I do have a lot to say, and questions of my own for that matter, but first I'd like to say thank you, Dave, for all your helpful information by buying you a cup of coffee!

I do have a comment, now that you mention it!











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